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What Are Debit Spreads and Credit Spreads?
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When you execute an option trading strategy that involves buying and selling more than one kind of option, then you are in essence, putting
on one what is called a "Spread". The Spread that you put on falls into one of these 2 categories in terms of capital outlay: Debit Spread or Credit Spread.
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A Credit Spread is when a high premium option is sold and a low premium option is bought on the same underlying security. When you put
on a credit spread, you profit primarily from the difference between the decay of the high premium option and the low premium option. You will
also end up with more cash in your account after putting on the spread, hence a "Credit" to your account. This credit to your account
is where the term "Credit Spread" comes from. Yes, you got me right, instead of having to pay money for putting on a credit spread, you are GIVEN
money for putting on the credit spread. As a credit spread involves a credit to your trading account, it is usually not a strategy that
traders can do without a huge cash margin. Many online brokers require a trader to have a cash balance of at least $100,000
before one is allowed to do a limited number of credit spreads. Another important feature of credit spreads is that they are able to profit if
the underlying asset stays stagnant through the decay and expiration of the more expensive short options. This is something not all debit spreads are
capable of.
A Debit Spread is when a low premium option is sold and a high premium option is bought. This is the most common type of spread which you
need to pay money to put on. Hence a "Debit" to your account. This debit to your account is where the term "Debit Spread" comes from. Anyone with
enough money to pay the debit can put on a debit spread. There are no margin requirements and is therefore the most popular kind of spread.
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